Retirement Planning Tips for Small Businesses

Small businesses face a litany of challenges every day, from paying bills and meeting payroll to bringing in new business, from collecting their accounts receivable to ensuring work is getting done on time. Often lost in the daily grind of “running the business” is the time or energy to consider the end of the road for every small-business owner: retirement.

All hard-working small-business owners owe it to themselves – and their loyal employees – to take the time to consider their retirement account options, and put one in place sooner rather than later.

 The best retirement plan for each individual small business owner will depend on a number of factors, including: how much money you earn, how many employees will be enrolled in the plan, whether you want to share profits or match employee contributions, and future growth plans for the business, among other considerations.

A significant difference between retirement plans available to small businesses lies in the annual contribution limits of each plan. The range is typically from $4,000 to $44,000.

If your salary is fairly small, and you would not be able to contribute a significant amount to a plan, you may be best-suited to an option available to any individual. A traditional or a Roth IRA, both with a $4,000 contribution maximum ($5,000 if you’re 50 or older), might work best for you. (Of course, even if you are participating in another retirement plan, you are still allowed to fund your own traditional or Roth IRA to supplement your retirement savings.)

If your salary is higher, and you would be able to contribute more than $4,000 or $5,000 to a retirement plan, a number of other options for the self-employed are available.

SIMPLE IRA
A SIMPLE (Savings Incentive Match Plan for Employees) IRA allows self-employed individuals and business with 100 or fewer employees to make tax-deductible contributions to individual retirement accounts set up for themselves and their employees. A SIMPLE IRA also allows small businesses to match employee contributions or contribute a defined amount per employee, depending on the way the plan is set up.

Both the business owner and participating employees have the option to defer up to $10,000 of their salary in annual contributions. Because of this fairly modest contribution limit, this type of plan is typically recommended for self-employed individuals or business owners earning up to about $75,000.

If a SIMPLE IRA is set up as a “matching” plan, both employers and employees contribute through salary deferrals, and the employer matches – dollar for dollar – the amount deferred by each employee (including the business owner), up to 3% of the employee’s salary. For example, if you are a business owner with a salary of $75,000 and contribute $10,000 to your plan, plus the 3% match (3% of your salary), your total plan savings for the year would be $12,250.

If a SIMPLE IRA is set up as a “non-elective” plan, the employer contributes 2% of each employee’s salary to the plan, regardless of whether the employee is participating by deferring compensation. All employer contributions to a SIMPLE IRA are immediately 100% vested.

Employer contributions are tax-deductible business expenses, and all contributions and earnings are tax-deferred until income is withdrawn from the plan, typically at retirement. In most cases, contributions are directed into variable annuity or mutual fund products and can be individually directed by employees.

SIMPLE IRAs are generally regarded as fairly easy to set up and administer, and typically have fairly low fees. They are offered by banks, brokerage firms and mutual funds.

SEP IRA
A SEP (Simplified Employee Pension) IRA may be best for a self-employed individual or business owner with a high income (more than $220,000). The reason is the high maximum annual contribution limit of $44,000.

SEP IRAs allow for tax-deductible contributions of up to 20% of your self-employment income (if you work as a sole proprietor) and up to 25% of your compensation if your business is a corporation.

Widely regarded as the easiest retirement plan to set up and administer, a SEP IRA can be opened as late as your tax filing deadline (including extended deadlines). So if you want to set up a last-minute plan to defer income before tax filing, this may be your plan. As with a SIMPLE IRA, the fees are low, and plans are offered by banks, brokerages and mutual funds. Also as with a SIMPLE plan, contributions are directed into variable annuity or mutual fund products and can be individually directed.

However, a significant difference between a SEP and a SIMPLE IRA is the way employees are handled. With a SEP IRA, you must contribute the same percentage for each employee as you contribute for yourself. For example, if you choose to contribute the maximum percentage of 25% for your own plan, you must also contribute 25% of each employee’s salary into their SEP as well, which is immediately vested.

If you are a small-business owner with mostly low-paid employees, a SEP will allow you to maximize your personal contributions while minimizing the cost of your employee contributions. But if your employee base is well-compensated, a SEP may not be the most advantageous plan.

Individual 401(k)
For sole proprietors or small-business owners with no employees whose income falls between $75,000 and $220,000, an individual 401(k) might be a good choice. Individual 401(k)s allow for tax-deductible contributions of up to 25% of your compensation, plus $15,000 in salary deferrals – up to a maximum contribution of $44,000 annually.

Despite sharing the same maximum contribution limit, an advantage that an individual 401(k) has over a SEP is the flexibility of contributions. You can contribute more when you are flush, and less during slow times with a 401(k), whereas you are locked into a contribution percentage with a SEP.

On the flip side, a 401(k) is less flexible than a SEP in terms of establishing and funding the plan. You must establish your 401(k) by December 31 and fund it by April 15.

Other differences are the more limited number of plan providers (see www.401khelpcenter.com for a list of companies that offer individual 401(k)s, as well as typically higher fees for setting up and administering the 401(k).

Finally, if your business plans to add employees in the near term, keep in mind that those employees must be added to your plan (typically after one year of employment), greatly increasing the monthly and annual administration costs.